Liquidity Problems In Commercial Banking In Nigeria

Liquidity Problems In Commercial Banking In Nigeria

Liquidity Problems In Commercial Banking In Nigeria

Liquidity is the word that the banker uses to describe his ability to satisfy demand for cash in exchange for deposits”. It can also be defined as the capacity of a bank to prompt demands that it payment obligation.

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A bank is considered to be liquid when it has sufficient cash and other liquid assets, together with the ability to raise funds quickly from other sources, to enable it to meet its payment obligations and financial commitments in a timely manner. In addition, there should be a sufficient liquidity buffer to meet almost any financial emergency.
How much liquidity to hold and in what form to hold it is a constant concern of bank management. Banks are required to comply with legal reserve requirements. In addition, banks need liquidity to meet seasonal and unexpected loan demands and deposit fluctuations. The majority of these transactions can be anticipated in advance and met from expected cash inflows from deposits, loan repayments or earnings. Cash reserves also are needed to take advantage of unexpected profit opportunities, or for what might be termed aggressive purposes. When a business firm that the bank has been working to secure as a customer finally represents a loan application, or a particularly desirable investment develops, the bank must have funds available to seize these opportunities. During periods of expanding economic activity,  banks are frequently presented with attractive loan situations which can only be met if banks maintain adequate liquidity. To determine the liquidity what a bank needs at a particular time is to find the ratio of loans to deposits.
The higher this ratio is, the less willing banks will be in lending out and vice versa.
In Nigeria, commercial banks activities are regulated  strictly by the banking Act of 1969 as amended under the control of the central Bank of Nigeria. As a result of these regulations by the central bank, the commercial banks are required to hold specific assets equal to a certain percentage of their deposits and certain other liabilities in liquid form. This is known as the legal reserve requirements. The legal reserve requirements are liquidity ratio requirement, cash reserves requirements, stabilization securities issued by the central Bank and special deposits. Liquidity problems, for the purpose of this study, are looked at as the problems,  encountered by bank managers who are responsible for liquidity management,   when  there is either excess liquidity or liquidity squeeze in the banking system or in the commercial banks.
It will be noted that since the end of the Nigerian civil war, the Nigerian financial system has been experiencing economic transformation which started as a result of the increasing inflow of foreign exchange receipts from the oil sector. This increase exerted preponderant influence on the liquidity of the economy. There was excess liquidity in the banking system. The Banks had little outlets for short term resources  and yet were not ready to commit the bulk of its short-term resources to long-term instruments. Commercial banks were faced with excess liquidity problems they had more funds than they can profitably employ.
But it is believed that the situation reversed with the introduction of second tier foreign exchange market (SFEM) under SAP. Banks are now faced with the shortage liquidity. This stems from the fact that they have been using the liquidity at their disposal to buy foreign exchange for sale  to their various customers, chiefly, for importation. This is because of the abolition of the import license system of foreign allocation.

There is no gain-saying, the fact that prior to the introduction of the structural adjustment  programme (SAP) of which the second tier foreign exchange market (SFEM) is the nucleus, the commercial banks in Nigeria has been wallowing in excess liquidity. Consequently they maintained excess liquidity ratios and were in the habit of refusing deposits from the public.
These may be accountable to some deficiencies in the management policies of the central Bank of Nigeria and the overall under-developed nature of the entire economic system. However, the structural adjustment programme with SFEM as the chief feature changed the trend. The situation became that of shortage of liquidity or liquidity crunch, as it is popularly called.
In any case, for the purpose of this research, the liquidity problems of commercial banks have been identified from two perspective:
One is that they had excess liquidity before the advent of second-tier foreign Exchange Market (SFEM).
The other is that shortage of liquidity have been telling hard on them since the existence of SFEM under SAP. In other words, this research takes a PRE-SFEM  and POST-SFEM stance on the liquidity problem of commercial banks.
With respect to the excess liquidity situation, this study intends to find out the effect of the excess liquidity in the banking system that is on the profitability of commercial banks. It investigates whether or not the policies imposed on the commercial banks by the central Bank have succeeded in mopping up the liquidity in the banking  system, and finally whether or not the  excess liquidity in commercial banks affects loans and advances to their customers.
On the other hand, the shortage of liquidity perspective, focuses on its (shortage of liquidity) effect on the profitability of commercial banks, whether or not the policies of the Central Bank can actually corrects the shortage of liquidity position of commercial banks, and above all how shortage of liquidity affects loans and advances to customers.

OPERATIONAL CONCEPTS IN COMMERCIAL BANKING IN NIGERIA
Admittedly, a lot has been written about liquidity problems in commercial banking in Nigeria. But most of the works, as a matter of fact, dwell on the prevailing situation before the introduction of the Structural Adjustment Programme (SAP) with the Second-tier Foreign Exchange Market (SFEM)as the main feature. As a result of this, the liquidity problems in commercial banking in Nigeria were not fully  exposed. This study therefore intends to  expose the liquidity problems of Nigerian commercial banks both  before and after the introduction of SFEM-pre –SFEM and Post-SFEM.
This is necessitated by the fact that prior to the advent of SAP of which SFEM is the nucleus, commercial banks in Nigeria were wallowing in excess liquidity due chiefly to unprecedented revenue from oil. But with the introduction of SFEM, the situation reversed to that of shortage of liquidity or liquidity crunch. For the purpose of this  study, the period under review is from 1997 to 2005, 1997 – 2003 representing post-SFEM period.
Under this section, we have to know among other things, the following;
a.    What is liquidity?
b.    Liquidity versus profitability and
c.    Liquidity problems in commercial banks in pre-SFEM and post-SFEM experience of banks.
a. What is liquidity?
The term liquidity has been variously defined, however liquidity definitions as will be given here are in the context of the banking business.
The liquidity of a bank is meant its capacity to meet promptly demands that it pays its obligations”.
Liquidity is defined as stated bank balances, cash in vault, and those government securities which have not been used as collateral for borrowing (i.e. unencumbered securities).
Looking at these definitions, one would immediately observe that they have a common feature, that is, that some assets are kept in anticipation of demand of customers. Liquidity is then a measure of the ease with which  commercial banks can meet the demand for withdrawal of their deposits.
As has been stated earlier, a bank is considered to be liquid when it has sufficient cash and other liquid assets together with the ability to raise funds quickly from other sources to enable it to meet its payments, obligations and financial commitments in a timely manner. In addition, there should be a sufficient liquidity buffer to meet almost any financial obligation. In order to remain liquid, banks hold assets which they consider liquid. The liquidity of an asset is the quality of the asset that makes it easily convertible into cash with little or no risk of loss. For instance, a naira bill is 100% liquid because it is already money and can almost automatically exchange for any other naira bill or  its equivalent value in coins. Similarly, a given volume of federal Treasury bills can be easily sold wih little or no loss, but an old care or equity stock is difficult o sell even at some substantial discount. The former is said to be liquid but the latter is illiquid.
Banks maintain liquidity for various reasons. The amount of liquidity a bank hold at a particular time and in what form to hold it are the concern of the bank management. Liquidity is one of the many problems  with which bank management struggles constantly. The amount of liquidity needed by individual banks depend on the amount of variations that occur in deposits and the demand of cash needs, the expected level of liquid assets, and cash receipts would be regarded to measure the liquidity that a bank need over a given period of time.
b. Profitability and Liquidity of Banks
At the micro level, an individual commercial bank is viewed as an  economic unit whose goal is to maximise profits. Banks had portfolios of assets and given the characteristics and distribution of their liabilities, they attempt to structure these in such a manner as to yield the greatest returns, subject to certain constraints.
The assets held by banks may be divided into two broad classes, frequently called earning assets and non-earning assets. Earning assets are the two groups of balance sheet items called loans and investments. Non-earning assets consists of fiscal assets, the total reserves of the bank, and non-interest earning deposits with the Central Bank. Profits are generated by earning assets (loans and investments) while liquidity is provided partly by earning assets like short term investments and partly by non-earning assets (e.g. cash balances held in the vault and at the Central Bank of Nigeria and cash reserves).
c. Equilibrium Between Profitability and Liquidity:
Why must banks profit? Banks make profit because, like other companies, they substantial costs and must earn an income at least sufficient to meet these costs and make an adequate return on thier assets. They are also accountable to their shareholders who have invested in them with the aim of good returns in the form of future dividends and growth. From these  points of view, banks need assets which produce income substantially higher than their expenditures.
A bank’s profit fulfils several other important function which may be summarised as: profit constitutes a buffer to absorb the shock of unexpected losses, especially losses arising from band debts. Every bank makes annual provisions in respect of doubtful value that their being sown as active assets of the bank becomes questionable.
Such provisions are made from profits from the perspective of excess liquidity in the banking system, it is common knowledge that due to the advent of oil revenue, these were an unprecedented rise in the growth  of commercial banks deposits liabilities.
This gave rise to the excess liquidity  in the banking system as banks had limited outlets for the investment of their idle funds.
In the same vein, banks could face liquidity problems under tight money conditions. In his book “commercial banking” Red, C.W. et al discussed liquidity problems under tight money conditions. He has this to say:
In a period of economic prosperity, disintermediation of deposits occurs, presenting serous liquidity problems for many commercial banks. Disintegration occur during “tight money” period when monetary policy is geared to slow economic expansion by limiting the availability of excess reserves to the banking system and pushing interest rate. He suggested that commercial banks should include adjustment to liabilities and capital fund in their management of funds as ways to meet their objectives of profitability and liquidity.
Cros and Hampel (1973) also considered liquidity problems of a banking system as that of having the demands for money that may be upon them.
The two vie was emphasised liquidity problems under tight money conditions (shortage of liquidity) as was witnessed in Nigeria during the currency change in 1984. and more recently in 1986 when SFEM was introduced under SAP. It will be realised that during the currency change exercise, commercial banks had great difficulty meeting the demands of their customers for cash, just as they had problems in paying  for foreign  exchange in local currency during SFEM operations and at the same time meeting customers’ demand for cash.
Apart from that, commercial banks in Nigeria are actually having a bitter experience. Shortage of liquidity or liquidity crunch with the advent of SFEM. This is confirmed by the fact that in only six weeks, the Central Bank of Nigeria (CBN)earned as much as N1.7 billion in its SFEM operation. The amount represents the naira equivalent of a total of  U.S. $50 million in September 26 (Maiden session). $50 million on October 16, $75 million on October 23, and $86 million on October 30.
Economic observers believe that there is now an acute liquidity shortage in the system. The August 1986- recalled by the CBN of naira deposits from commercial and merchant banks for foreign exchange application awaiting cover started that trend which worsened the situation.
Another one is the cancellation of foreign guarantees for naira-dominated loans. By this, the banks were required to call back such loans or have their equivalents automatically debited in their CBN accounts. Again, other measures that contributed to this worsening liquidity shortage were the liberalisation of the Foreign Exchange Market (SFEM), this single action led to the withdrawal of over N10 billion deposits held by banks against letters credit.
The last was the withdrawal of deposits of parastatals and other government agencies form commercial and merchant banks.
This resulted in withdrawal of over N5 billion from the system and caused incongruence in the assets and liabilities profits of many banks.
The implications of all these development, is that the transactions and business motives of consumes and business will no longer be satisfied. Besides, the bank will now be under severe pressures as it will not be too easy for them to attract fresh deposits even with advances they make.

LIQUIDITY RATIO
Liquidity ratio refers to the minimum proportion of commercial banks, assets which they are legal required to keep in liquid form. The more easily an asset can be converted into cash, the more liquid it is, cash itself is therefore eh most liquid asset.
Liquidity ratio can also be defined as the percentage of total deposit liabilities which commercial banks are required by law to keep liquid.
It can be said that liquidity requirements become influential on final management as so as the commercial banks began lending all deposits. This is because from then on, they had to take rational decisions on the prudent level of cash reserves necessary to meet the demand of depositors.
The fixing and control of liquidity ratio in each country is the responsibility of a central authority such as the Central Bank of Nigeria.
Liquidity ratio vary from country to country both in structure  and its contents. In the United States for example, the Federal Reserve Bank defines the qualified liquid assets to include only two items: Deposits of a member  bank at the Federal Reserve Bank and cash in the vault of the member bank. In addition, liquidity ratio is operated on a graduated schedule such that the marginal liquidity ratio increase with the amount of deposit. It also varies with the geographical location of such commercial bank.
For the Bank of England, the definition of liquid assets includes the following:
i.    Cash and balances with the Bank of England and with other banks.
ii.    Money at call and short notice.
iii.    Treasury bills.
iv.    A portion o commercial bills and government stock which can be turned into cash within a relatively short time.
England has been using a 28% liquidity ratio since 1963.
The Central Bank of Nigeria 1962 Amendment Act defined assets which can  form part of the liquidity ratio to include:
a)    Notes and coins which are legal tenders in Nigeria.
b)    Balances at the Central Bank.
c)    Balances at any other bank in Nigeria and money at call.
d)    Treasury bills issued by the Federal Government and maturing within 91 days.
e)    Inland bills of exchange an promissory notes – re-discountable at the Central Bank.
f)    Net balances at any bank including the office an branches of a licensed bank in such monetary areas as the Central Bank may have approved for this purpose.
g)    Money at call in monetary areas approved by the Central Bank under paragraph.
h)    Bills o exchange bearing at least two good signatures and drawn on and payee in the approved monetary area within 184 days.
It was specified that he Central Bank would from time to time decide on the foreign assets to be included. The above examination of what constitute liquidity assets in three countries – United States, England an Nigeria suggests that there are two broad definitions of what can form part of the liquidity ratio. One limits liquid assets to cash, this obtains in the United States. The other includes other relative liquid assets which are easily transformable into cash – this obtains in Nigeria and England.
An appendage to the categorisation is that  whereas the United States operates differential liquidity requirements depending on such things as the size of deposits, geographical location of the bank, and whether or not the bank is a member of the  Federal Reserve system. Nigeria operates a uniform liquidity requirement for all commercial banks.

SIGNIFICANCE OF THE LIQUIDITY RATIO

Having thus far attempt to explain the meaning of liquidity ratio in Nigeria, it is proper to investigate the rationale for such an instrument. The original purpose of liquidity ratio was to provide commercial banks with cash in some proportion to deposits, so as to assure depositors of convertibility of their deposits into cash. That is, it was designed to provide a primary line of defence for a bank in meeting withdrawals of depositors either by hand, in cash or by cheque. This requirement was though necessary in order to maintain the credibility of customers for inability to meet demand for cash would mean failure or at least loos of confidence in the banks.
Even thought the objective looks plausible, it is likely that it can be achieved equally without the ratio instrument. This is because in the first place, banks will always want to satisfy their customers, for if they did not, their services will to be demanded an they would be forced to fold up. Moreover, any one banks cannot procure a credit policy which differ to any considerable extent fro that of other commercial banks. What happens at the clearing house  where net cash drains have to be the credit aims of an individual bank.
The most generally accepted purpose of liquidity ratio is its use for regulating bank deposits and indirectly the volume of bank, assets. As the liquidity ratio rises  or falls, so do commercial banks’ loans and  investments fluctuate in the reverse directions. Correspondingly, the volume of economic activity would fluctuate.
The need for regulating bank deposit stems from the fact that commercial banks can and do create deposits. This is made possible by the  issue of cheques drawn above the actual cash deposited with it. Such happens  when a commercial bank grants loans or overdrafts to businessmen and other customers. Since these cheques can generally be used in transactions, they are for almost all practical purposes, money. Theoretically, then, the commercial banks can go on creating more and more money simply by issuing cheques.
In practice therefore, a prudent bank management of funds requires that a certain minimum level of cash or other liquid assets, easily convertible into cash be reserved. The amount of  such reserve will be such that it can support a given volume of deposits. The bank can then expand its deposit in proportion to its reserves.
Suppose the Central Bank prescribes a liquidity ratio of 10%, this means that if the First Bank, for example, has received a total initial deposit of N100 from its customers, then N10 represents only 10% (1/10) of the total deposit. It is allowed to create, in effect, and can issue cheque worth N90 (i.e. 90% of N100)

COMPUTATION OF LIQUIDITY RATIO:
In Nigeria, by regulation, there is a minimum specified liquidity ratio that must be maintained by banks. In computing the liquidity ratio, the acceptable   liquid assets are:-
(a)     Cash
(b)    Balances held  with the CBN less any shortfall of loans for agriculture and residential buildings (ie money deposited with the CBN to cover the remaining volume of loans for agriculture and residential building which  the bank must lend out under credit guidelines issued by the CBN).
(c)    Balances held with internal banks (excluding uncleared        effects, (ie uncleared cheques mainly less balances held for internal bank. (if not mins, then the quantities added to current liabilities),
(d)    Nigeria treasury bills,
(e)    Money at call held with other banks,
(f)    Certificate of deposit of not more than 8 months to maturity.
(g)     Government securities (eligible stock, ie of not more than 3 years to maturity)
(h)    Bankers unit fund.
Current Liabilities of a bank include:
(a)    Current (Demand), savings (pass-book) and time deposit accounts,
(b)    Certificates of Deposits issued (if not more than 18 months to maturity),
(c)    Excess balances held for internal banks,
(d)    Balances held for external office less any balance held with external offices (if not minus ignored).

Then, liquidity ratio = Total Specified liquid Assets      X  100
Total Current Liabilities             1
Deposits made with the central Bank  in respect of shortfalls on loans to agriculture and residential buildings construction and cash holding for meeting cash reserves and deposits for letters of credit do not count for the purpose of computing liquidity ratio. Reserve requirements must be met on a monthly average basis, so it may be under or over the required level on any one day.
When a bank’s reserves excel legal requirements, it may adjust its position by setting the surplus to another bank in order to earn interest on these funds.
Similarly, a bank that has not met reserve requirements must take steps to cover the deficiency by increasing its deposit base. In the event of a temporary shortage of liquid cash, call money can be purchased from other banks. These transactions are effected through the banking offices of the central Bank by debiting and crediting the respective bank accounts.

CASH RATIO
The central Bank of Nigeria requires banks to maintain a non-interest earning reserve against demand deposits. “The cash deposit is expressed as a ratio of each Bank’s total demand deposit  liabilities”. Each commercial Banks maintains a minimum amount of cash deposit with the CBN Banking office in Lagos. For the purpose banks are classified into four classes. It should be noted that the classification is based on total deposits whereas the ratio itself is a ratio of cash to total demand deposits.

These reserves are carried in form of frozen deposits at the CBN. With effect from June, 1999 the CBN assumed the responsibility for calculating the cash reserves of all banks. Each bank was debited with the appropriate percentage (ie 6-9% as stated above) of its total demand deposits which was immediately placed on a non-interest earning cash reserves accord with the Bank. Thereafter, the calculation is repeated every month and the reserve is either increased or reduced in accordance with the position of demand at the end of the month. When there is growth in demand deposits, the banks current account at CBN is debited and the reserved account added with and the difference in order to raise the percentage to the appropriate level and vice-versa. When there is a drop in demand deposits. Thus, after the initial deposits, subsequent debits or credits to the reserve account are insignificant.

 

LIQUIDITY RISK

This is the risk that funds will not be available to meet deposit withdrawals, loan drawn-downs, maturity of borrowing or other cash outflows. Bank liquidity is managed with the aim of meeting the following objectives:

(i) Assuring credit customers that funds are available to provide for their withdrawal of funds upon demand or at maturity.

(ii) Assuring deposit customers that funds are available to meet their borrowing requirements.

(iii)Maintaining access to liquid reserves sufficient to enable the bank to respond to potentially profitable credit or investment opportunities.

(iv) Diversifying sources of funds in terms of types of the instruments and maturities.

(v) Maintaining the statutory liquidity ratio 30% and also satisfying the CBN to the banks ability to meet its demand deposit under varying economic and financial conditions.

Liquidity is available on both the asset and liability sides of the balance sheet. Assets liquidity resides in:

(i)The ability to convert assets to cash; and

(ii) The self-liquidation of assets – liquid assets which can be sold to other banks or an market, which include marketable securities and certain loans:, maturing loans, and inter-bank placements provide liquidity as they are repaid.

Liability resides in the bank’s ability to:

(i) Attract deposits, and

(ii) Issue money market, liabilities and negotiable or non-negotiable certificates of depositors

Assets liquidity and liability liquidity should be geared as co-equal elements in any liquidity management policy. In terms of very short-term assets and liabilities, however, great liquidity generally is available on the liability side of the balance sheet. Investible funds tend to be fully utilized at any given time but additional liquidity can be generated through the banks access to the money market. Through the issue of negotiable certificates of deposits, inter-bank borrowings, call money, rediscount arrangements and the issue of commercial paper. The domestic liquidity of banks also resides to a great extent in their retail deposit base (demand, savings, and time deposits).

Ultimately, a bank with a persistent liquidity problem must curtail its lending activities as excessive lending is usually the cause of a shortage of liquidity. If a bank is unable to attract sufficient deposits, but continues to expand its lending activities, this will result in illiquidity.

LIQUIDITY REQUIREMENTS OF COMMERCIAL BANKS IN NIGERIA:

The idea of liquidity requirement arises as follows: The bankers need to have some funds as cash or secondary reserves to meet withdrawals of depositors. The deposit liabilities of banks which have vary high turn-over rates require more liquid assets to high frequency than equivalent time deposits.

So, we say that these two deposits have different liquidity needs. In providing for liquidity bank management must reorganize the many movements in the economy like seasonal, irregular, cyclical and secular movements. Seasonal movements are directly related to the changing seasons by repealing themselves every year. The precise seasonal pattern may change with the passage of time. A bank located in an agricultural area might enjoy a high level of deposits at onset of the dry season after crops are harvested and experience a high loan demand at the beginning of the rains. Weather is the most important factor responsible for seasonal patterns, but social custom has an influence-for example retail sales normally rise in December because of the Christmas season.

Irregular movements are often difficult to predict, in terms of their occurrence or severity since they do not follow established patterns.

They do however, affect the level of deposits and the demand for loans. Examples of irregular movements are a labour strike, the effects of some natural catastrophe such as earthquakes or a flood, a war scar, or some unusual economic or political development.

Cyclical movements are the alternating booms and burst which characterize free market economies, especially in the west. Cyclical movements are more difficult to predict than seasonal movements.

During the contraction period of a business cycle, loan demand declines because of slump in business, and deposits may shrink because of falling income (consider retrenchment in self-reliant or mature economies, the monetary authority adopts monetary policies which tend to offset the contraction of deposits, but not always at the same rate. In some period of prosperity disintermediation of deposits occurs, presenting serious liquidity problems for many commercial banks. This scenario is experienced in the well-developed market economies of the west.

Nigeria as an immature economy is characterized by institutional inadequacies such as under banking, primitive habits of the population in respect of saving and investment, a highly skewed income distribution (with only a very small portion of the population monopolizing the gross national output ), etc. it is therefore not surprising that our economy exhibits behaviour we would consider perverse with regard to the banking terms. Moreso, there is this anomaly of high profits in periods of excess bank liquidity. Again, because of the foreign exchange bottlenecks, we can have a recession in Nigeria and yet have abundant deposits in the banks such as was case in the period 1979/2005.

Since the salaried and wage earning classes own very small volume of bank deposits, the fall in their aggregate income would only marginally affect total volume of deposits during recessions. The nature of our economy encourage certain groups such as smugglers, hoarders, monopolies and Oligopolies to prosper amidst general shortages.

Secular movements or trends are those changes in the economy occurring over a long period of time. For example, inspite of all other movements in the economy has an average been rising or falling. By mathematics methods such as time series analysis geometric forecasting techniques. Bank managers can determine whether liquidity needs would increase on the average over the years or else fall.

Liquidity requirements become influential on fund management as soon as the commercial bank lending began lending out deposits. This is because from then on, they had to take rational decisions on the prudent level of cash reserves necessary to meet the demand of depositors.

All the commercial banks in Nigeria are required by law to keep specified liquid assets Which shall be expressed as a ratio of deposit liabilities. This is known as liquidity ratio refers to the minimum proportion of commercial banks assets which they are legally required to keep in liquid form.

The liquidity of an assets is the quality of an assets that makes it easily convertible into cash with little or no risk loss. For example, a naira bill is 100% liquid because it is already money and can almost automatically exchange for any other naira bill or its equivalent value in coins. Similarly, a given volume of federal government treasury bills can be easily sold with little or even at some substantial discount. The former is said to be liquid, but the later are liquid.

The items of a portfolio of assets have varying degrees of liquidity. The most liquid being cash and other reserve assets.

Thus, assets might be arranged along a continuum for most to least liquid cash is the liquid assets, and the cash with which other assets can be converted into cash (through sale or collection) provides the standard of liquidity of any security because they can be readily sold in the money market without substantial loss. Among the least liquid of assets are bank promises. A banks loans are in a sense, though, the last liquid of its assets. Buildings usually can be sold, even though the transaction may be subject to some delay and substantial discount. For many type of loans there is no resell market, and the only way they can be converted to cash is to collect them at maturity.

Regular amortization of the principal through monthly payment can provide considerable liquidity to a loan portfolio, but it could be difficult to liquidate the entire portfolio.

It is to be noted that the fixing and control of liquidity ratio in Nigeria is the responsibility of the central bank of Nigeria (CBN).

The bank had also power to require commercial banks to hold a maximum amount of specialized liquid assets which shall be expressed as a ratio of deposit liabilities.

The specified liquid assets comprises notes and coins which are legal tender in Nigeria, balances of the central bank and at any licensed bank in Nigeria, money at call in Nigeria, Treasury Bills and Treasury certificate issued by the federal government of Nigeria, Inland Bills of exchange and promissory notes rediscounted at the Central Bank of Nigeria (CBN).

The determination of the liquidity requirement of a bank asset with the bank management. In general, this is often associated with a prudent management of the bank’s assets. The allocation of bank funds to various assets classifications in constrained by regulations and law, by the need to maintain a high degree of liquidity, and by the need to earn sufficient income. The central problem of assets management is to balance need for liquidity with the desire for profit.

Banks are compelled to maintain fixed minimum liquidity ratio in Nigeria mainly because of the need to balance the pursuit of profit and the need to remain liquid. Every bank is faced with the choice and it usually discovered that actions designed to raise liquidity for the stipulated level would generally reduce earnings. While actions designed to increase earnings may reduce liquidity. However, as illiquidity appears to be an unacceptable caption, profit opportunities would be pursued without incurring undue exposure to liquidity risks. So, the bank must strict a balance between adequate liquidity and its reducing effect on profit and high profitability with the consequent worsening of the liquidity position.

Liquidity is one of the many problems with which bank management struggles constantly in advanced economist. The perversity of the Nigerian situation arises from the general problems of underdevelopment and immaturity. For example, in Nigeria, for some period, all commercial banks in the country were bulging with liquidity. They all consistently maintained liquidity ratios for higher than the statutory 15 percent. This is further illustrated by figure 1.2 and 1.3. however, it is believed that the trend had reversed with the advent of Second-tier Foreign Exchange Market (SFEM).

There is no foolproof formular for determining a bank’s liquidity need. The amount of liquidity needed by an individual bank depends on the amount of variations that occurs in deposit and demand for loss.

LIQUIDITY PROBLEMS OF COMMERCIAL BANKS IN NIGERIA

As has been explained in the preface, the general considerations of liquidity problems of commercial bank is demand appropriate here, since the banks shares similar experiences during period of excess liquidity and conversely, periods of shortage of liquidity as presently the case. This is the writer presumes, will eliminate unnecessary reputation and perhaps distortion of facts.

Liquidity in its most elementary definition is the availability of liquid resources to meet current demand. Liquidity problems arise either as a result of the banking system having excess reserves or little reserves to meet demand.

Liquidity problems that will e discussed here are those associated with both excess reserve and little reserves- Excess liquidity and shortage liquidity. The formal is designated ‘PRE-SFEM EXPERIENCE’ and the later ‘POST-SFEM EXPERIENCE’ in this treatise.

2.6.1 PRE-SFEM EXPERIENCE

A lot of factors have been identified a the causes of excess liquidity, which commercial banks in Nigeria experienced prior to the introduction of SFEM. Among the factors are

First on the least was the increase of foreign exchange receipt from the oil flow. This increase exerted Preponderant influence on the liquidity of the economy and put at the disposal of the financial system unprecedented levels of liquidity.

– Secondly, due to the unsophisticated and rudimentary nature of our money market, there were few markets for short-term investments for the commercial banks.

– Thirdly, the commercial banks in Nigeria were quite unwilling to commit the bulk of their resources to long-term investment. This explains why they were “chocking credit expansion to the private sector”. And cared less to finance agricultural production which attracts lower interest and fairly generous maturities.

– Fourthly, the specified liquid assets for computing the liquidity ratio include notes, coins which are legal tender in Nigeria, balances at the Central Bank an at any licensed bank in Nigeria, money at call in Nigeria, and inland bills of exchange and promissory notes rediscountable at the Central Bank of Nigeria. While the cash ratios is differentiated for various classes of banks, the minimum liquidity ratio required of banks is 30% for all banks.

– However, computation of liquidity ratios excludes the amount of cash held by a bank to meet cash reserves requirements, or invested in stabilisation securities issued by the Central Bank, or advance deposits made in respect of letters of credit. This in effect amount to an increase in the liquidity ratio required of commercial banks

– Fifthly, the composition of specified liquid assets creates a market for government securities at the same time, it underscores the efforts to develop a local money that provides the banks with outlets for investment of funds in a manner to satisfy their needs for liquidity and earnings. It is no longer necessary for banks to export the entire cash surplus to their requirements into foreign money market in search of earnings or to maintain large amounts of idle cash that fields no income. This does not imply that the problem of the narrowness of the local money market has been solved.

– Sixthly, one of the reasons for the importance of the liquidity ratio in Nigeria relates to the items included in the liquidity list. The Central Bank’s definition of liquidity assets included such income earning assets as Treasury Bills, inland Bills, money at call ans other re-discountable items. The implication of this amorphous list is that the deposit created by a commercial bank forms a part o t the liquidity ratio, thus a commercial bank goes on creating deposits while at the same time satisfying the liquidity requirement. Under this circumstance, the Central Bank cannot employ the liquidity ratio effectively for monetary control since the liquidity ratio seems to be determined by the amount of deposits created by commercial banks. This explains the curious phenomena of very high levels of liquidity ratio of commercial banks in the recent past.

POST-SFEM EXPERIENCE

In nature and self-reliance free market economies , the ‘tight money period s one when monetary policy, results in limiting the availability of excess reserves to the banking system. This restriction on growth of reserves causes a fall in the supply of loanable funds and also a fal in money supply.

By a self-reliant economy, we refer to an economy whose enterprises depends on their own technology, especially, so that changes in aggregate output results only from the desired behaviour of the producers in response to market conditions. In the case of Nigeria, where everything including manpower must be imported, the behaviour of producers cannot be ‘natural’ the induced by extraneous events in the foreign sector. You cannot therefore, have the correct or full expected responses to changes in economic variables.

However, the ‘light money’ or shortage of large condition in Nigeria studied in this work is that caused by the Structural Adjustment Programme (SAP) with SFEM as the chief features. SFFEM was the most well known of the Structural Adjustment efforts. It was a logical follow-up to the foreign currency domiciliary accounts which was established some time ago to enable people keep foreign accounts in the country.

SFEM is a form of multiple exchange rate arrangement in which foreign exchange purchases are made on different rates depending on criteria chosen by the regulators of the economy. With particular reference to Nigeria’s SFEM arrangement, a two-tier system of foreign exchange transactions exists in which most transactions are shortage of liquidity in the banking system came fin the wake of the Structural Adjustment Programme of which SFEM is the nucleus. SFEM is designed to achieve some realistic exchange rate for the naira which will serve as a stepping stone for the structural re-adjustment of the entire economy. The shortage of liquidity was the product fo the following: firstly in order to induce some stability in the rae of the naira and see also that the currency is not depreciated much, the Central Bank embarked on a massive mopping up of liquidity in the economy. As a first step, all naira deposits made by the imports for trade transactions, whose settlement was still a subject of negotiation between the country and the explorers, were recalled suddenly in August, 1979. the total amount involved is thought to be around N3.3 billion. More liquidity was mopped up in October when the Central Bank of Nigeria (CBN) recalled the remaining portion of such free funds in the bnking ystem. The development has already had an immediate impact on the portfolio of banks. Secondly, in only six weekends, the Central Bank of Nigeria earned as much as N1.7 billion in its Second-tier Foreign Exchange Market operation. The amount represents the naira equivalent of a total of U.S $416 million, which it injected into the market in the six bidding sessions – $50 million in September 26 (maiden session),

$50 million on October, $75 million on October 30.

The third was the liberalisation of the Foreign exchange market.. this acion led to the withdrawal of over N 10 billion deposits held by banks against letters of credits.

Fourthly, as the cancellation of foreign gauranteesfor naira denominated loans. By this, the banks were required to call back such loans or have their equivalent automatically debited in the CBN accounts.

Finally, there was the withdrawal of deposits of parastatals and other government agencies from commercial and merchant banks. This revealed in withdrawal of over N5 billion ffom the system and caused incongruence in the asets and liabilities profiles of many banks.

The implication of all these development is that the transactions and business motives, consumers and businessmen was no longer satistified. Besides, the baks wee unde severe pressure asit was not too easy for the m to attract fresh deposits evenwith the advances they made. Of couse, that was the beginning of the crisis. For every bidding, the bank deposits were usually further depleted.

In any case, the government has taken some steps to ameliorate the situation in sch a way that the objective of the Structural Adjustment Programme will not be jeopardized.

POLITICS INTRODUCED BY THE CBN IN SOLVING LIQUIDITY PROBLEMS OF COMMERCIAL BANKS IN NIGERIA

PRE-SFEM POLICIES

The government throught the Central Bank introduced some measures to help solve the problems of eces liquidity of commercial banks. This is becase the excess liquidity of banks raised, among others,the problems of adequate short-term investment outlets for the surplus cash reserves of the banks. Some of the measures employed include:

– Banks are required to hold a minimum amount specified liquid assets which shall be expressed as a ratio of deposits liabilities. This is the liquidity ratio of banks which was 30% for all banks. It is meant to reduce banks liquidity.

– The Central Bank of Nigeia also requires commceral Banks to maintain a non-interest earning reserves against demand deposits. The cash deposit is expressed as a ration of each bank’s total demand deposit liabilities. This iscalled the cash ratio. These reserves are carried in form of frozen deposits at the CBN with effect from June, 1979, the CBN assumed the responsibility for calculating cash reserves for al banks. Each bank was debited with the appropriate percentage (i.e 6-9%) of its total demand deposits which was immediately placed on a non-interest earning cash reserve account with thebanks.

– As one of its measures toward the reduction of excess liquidity in commercial anks, the Central Bank excludes some assets such as stabilization securities, special deposits, amount of cash held by bank to meet cash reserve requirements from the computation of statutory ratio of commercial banks.

– Some other measures employed by the Central Bank at variouis times include adjustment of interest rate structure, reduction of laons and advances to commercial banks, various purchase of treasury obligations an various occasions of moral suasion.

In employing these measures, however, the Central Bank has had to contend with the reality of the enormous powers of the multi-national banks that dominate the Nigeian banking system.

However, the most remarkableofall government’s effort aimed at reducing excess liquidity cam in the wake of the Structural Adjustment Programme with SFEM as the chief component of the naira, and see also that the currency is not depreciated much, the Central bank embared on a massive mopping up of liquidity in the economy. As a first step, all naira deposits made by the importers for trade transactions, whose settlement was still a subject for negotiation between the country and the exportes were recalled suddenlyin August, 1986. The total amount involved is thought to be around N3.3 billion . More liquidity as mopped in October when the CBN recalled the remaining portion of such ‘free’ funds in the banking system.

From the SFEM operations, the CBN in only six weeks earned as much as N1.7 billion. The amount represents the naira equivalent of a total of US $416 million which it injected into the market in the first six bidding sessions. $50 million in September 26 (maiden session): $50 milion on October 2: $75 miliion on October 9: $50 million on October 20. This mopped up a substantial proportion of banks liquidity.

POST-SFEM POLICIES

The government took a number of steps to avert the shortage of liquidity in its 1987 and 1988 budgets respectively. Some of the measures include:

i. The intenal debt servicing of government which would enhance liquidity in the economy in eneal. An example is the allocation of N700 million to contractors for the settlement of their outstanding debts. This huge sme is usually deposited with the commercial banks.

ii. Tax Relief:

Tax reduction for both individuals and companies may increase banks’ liquidity if these tax savings are deposited with banks, for example, company income tax was reduced from 45% to 40%.

iii. Interest Rate Adjustment

The Minister of Finance announced an interest rate structure with a ceiling of 12.5% interest on bank lending and a minimum interest rate of 10 percent on savings deposits. Time deposits are also to attract a minimum interest rate of 10 percent. The flexibility being introduced by the structure is to one’s mind inadequate in mobising local savings and encouraging foreign capitial inflow. This becomes glaring when the rae of inflation and investment returns are taken into consideratio.

iv. Abrogation of the Input Levy

With the coming into operation of SFEM, part of 50% import levy was abolished. This will enhance the profits of companies concerned which will in turn, increase deposits in banks.

v. The abolition of Air Travel levy of N100 will, in a way enhance the disposable income of individuals will invariably lead to increase in deposits in banks, if individuals adopts banking habit.

vi. Advance Payment on Import Duty;

The advance payment import duty in has been reduced to 25% of he assessed import duty in orde to improve the financial liquidity of companies. This took effect from 1st January wn the goods arrive and the actual customs duty properly assessed.

Improvement on the financial liquidity of companies will indirectly lead to improvement on the financial liquidity of banks, too via deposits.

vii. Foreign Investments

In the budget, the government made pronouncement directly aimed at attracting foreign investment. Government seems to be opening up to foreign investment and abandoning its socialized stance towards foreign investments. There is a delibrate policy to attract foreign investment into the areas of agriculture and petrochemicals. For the first time also, this kind of holiday-package of 3-5 years has been approved. “Just and the threshold of expatriate income that can be transferred has increased from 50% to 75%. No doubt, the inflow of foreign investment would help alleviae the liquidity problems of banks through the foreign exchange that it will attract an the job opportunities to be provided to many Nigerians. Other measures included in the 1989 budget to solve the liquidty problems of banks include;

viii. Deposit Insurance Scheme;

It was announced by the Minister of Finance and Economic Development that an institution to be known as Nigeria Deposit Insurance Corporation will be established in the country in 1989. the schem will protect depositors fnds against bank failure and thereby generae greater confidence of members of the public in our banking sysem. This policy will encourage banking habit in the country thereby boositing commercial banks’ liquidity through increased deposits.

ix. Fund for Small and Medium Scale Enterprises

The Minister for Budgeting and Economic Planning, Alhaji Abubakar Alhaji also announced the establishment of a National Economic Reconstruction Fund (NERF) to an the rise of valid small and medium scale enterprises. The fund was amed at ‘removing some of the important factors which have over the past 27 years discouraged the support of our banks to the vital sector of the economy. Increased performance of these industries will consequently lead to improved liquidity of banks via deposits. Other measures promulgated in the 1989 Budget which can enhance banks liquidity position (either directly or indirectly) includes the establishment of small farmer’s credit programme, allowing merchant and commercial banks to take fully in mall and medium scale enterprises, the establishment of the Peoples Bank, the introduction of the Communicaiton Banks and so on.

It is really very sad to note that up till now, most of the above proposals have not been implemented. Ast it turned out aftersome months. The legal instruments for implementing he programmes are still on the drawing board.

It cannot be gainsaid that there are a lot of contradictions in the above government policies. This is a common feature of our policies is that they lack adequate implemtation. However, it is hoped tht the 1990 budget (i.e. the monetary an fiscal policy measures aspect) will solve the economy from excessive and suffocating bureaucratic controls and loss making tendency and set the economy towards the course of revival.

Liquidity Problems In Commercial Banking In Nigeria

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